Non-Agency Residential Mortgage-Backed Securities: The Future is Now
New issuance and trading activity in the RMBS market reflect a change in investor focus.
This Non-Agency Residential Mortgage-Backed Securities sector report is excerpted from the Fourth Quarter 2019 Fixed-Income Outlook.
Non-Agency RMBS has exhibited positive performance over 2019, returning 1.4 percent in the third quarter and 7.4 percent year to date. Although performance was directionally positive, the sector’s moderate interest rate sensitivity and spread volatility resulted in more tepid performance than the Bloomberg Barclays U.S. Aggregate index and other credit sectors.
Trading volumes and investor participation in the secondary market was low in the third quarter and did not meaningfully increase from the quiet summer months, but new issuance spiked after August and was well received by investors. New issuance reached $24 billion in the third quarter and $61 billion year to date. After 10 years of negative net issuance, 2019 issuance is expected to exceed the paydowns from the outstanding market, resulting in positive net supply and a stabilization in overall market size.
Non-Agency RMBS issuance restarted in earnest over 2013–2015 with the establishment of the GSE credit risk transfer (CRT) programs, and regular non- and re-performing backed deals and non-QM and jumbo prime deals. With increased new issuance, the composition of the non-Agency market has shifted away from pre-crisis and towards post-crisis securities.
Post-Crisis Bonds Now Represent Approximately 37 Percent of the Market
Post-crisis RMBS accounted for just 10 percent of the market in 2016. It now accounts for one-third.
Source: Guggenheim Investments, CoreLogic, Citi Research. Data as of 9.30.2019.
Post-crisis RMBS comprised only 10 percent of the market in 2016 but now comprises approximately 37 percent of the market. Post-crisis RMBS has maintained reasonably stable underwriting standards, while the credit-sensitive pre-crisis sector has exhibited ongoing credit improvements. These trends have contributed to a decline in the overall riskiness of the sector and a corresponding broadening of investor sponsorship. Although the shift in composition away from pre-crisis deals began with the re-opening of primary RMBS issuance in 2013, trading volumes remained stubbornly focused on the pre-crisis segment and only recently began migrating towards post-crisis tranches.
Trading Volumes Migrated to Post-Crisis Issuance
Trading volumes have mirrored outstanding volumes and have begun migrating to post-crisis issuance.
Source: Guggenheim Investments, SIFMA. Data as of 9.30.2019.
We remain constructive on the performance prospects for non-Agency RMBS as borrowers continue to benefit from favorable consumer-credit and housing fundamentals, which should translate to stable credit performance of recent issuance and improving bond cash flows for pre-crisis deals. We continue to favor senior, shorter maturity classes for their lower price volatility as well as selected credit-sensitive, pre-crisis passthroughs that should benefit from constructive credit fundamentals.
—Karthik Narayanan, CFA, Managing Director; Roy Park, Director
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